Can Cupcake-Maker Crumbs Hit the Sweet Spot on Growth?

The Food Network may air a show called Cupcake Wars, but when it comes to dramatic rivalries with his competitors in the increasingly crowded cupcake-store sector, Jason Bauer will have none of it.

"I've never had a bad cupcake in my life," says Bauer, CEO and co-founder of the 34-unit Crumbs Bake Shop, when asked about how his cupcakes stack up against those from stores like New York-based Magnolia Bakery or Beverly Hills, Calif.-based Sprinkles Cupcakes. "The more people in the category, the better it will be for the category."

Granted, Bauer has good reason to be gracious. The company he started in 2003 with his wife, Mia, as a single bake shop in New York's Upper West Side, now claims to be the largest U.S.-based retailer of cupcakes. Crumbs is being purchased for $66 million by 57th Street General Acquisition, which in turn plans to take it public, listing it on the Nasdaq as early as next month. After that, explains Bauer, Crumbs plans to expand to about 200 stores by the end of 2014, and as many as 600 stores thereafter.

"Crumbs is an immediately recognizable brand with broad demographic appeal," said Mark Klein, CEO of 57th Street, on a conference call earlier this week. "It's a true growth company."

The Next Krispy Kreme?

But whether Crumbs will turn out to be a sweet deal for investors in the long term is harder to predict. Krispy Kreme Doughnuts (KKD) and Pinkberry were among the optimistic dessert specialists lured by surging popularity and large margins to rapidly open new stores, only to close many of them after unit sales fell.

Krispy Kreme, which was founded in 1937 and went public in 2000 based on the popularity of its hot glazed doughnuts in the South and on the East Coast, saw its stock price more than double within three years and had expanded to almost 400 stores by early 2004. By the end of that year, though, same-store sales had gone negative after the company broadened distribution to include supermarkets, big-box retailers and other outlets, while much of management had turned over. The stock, which went public at $21 a share, plummeted to close to the $1 level in early 2009. It now trades at about $7.

Likewise, closely held Pinkberry fed the revival of the tart frozen yogurt craze -- fans have been known to refer to it as "crackberry" because of its addictiveness. Since its 2005 founding, the chain has since expanded to more than 100 stores worldwide, but its success has inspired a number of less-expensive knockoffs. While the company continues to expand into markets such as Washington, D.C., and Miami, it has also shuttered at least a half dozen stores in the Los Angeles area in recent months.
Big Money in Small Desserts

With Crumbs looking to multiply sixfold within three years, the company risks repeating history, especially with the food and beverage industry only slowly recovering from the recent recession, according to Bonnie Riggs, restaurant industry analyst at NPD Group. "This is a highly discretionary, indulgent product," says Riggs. "If we were five years back, it'd be a whole different ballgame."

Riggs adds that by expanding rapidly, Crumbs also runs the risk spurring competition from larger food and beverage companies like McDonald's (MCD) and Starbucks (SBUX), which could both easily jump into the cupcake fray.

Granted, Crumbs' financials are impressive. Last year, the company generated about $1.8 million in net income on $31.1 million in sales, and it opened seven new stores, the company said in a preliminary earnings estimate this week. Crumbs estimated that it may double profit this year to as much as $3.9 million as it opens as many as 21 new stores and boosts its revenue to as much as $50 million.

A typical Crumbs store generates more than $1,000 of annual sales per square foot, numbers that put the company on par with McDonald's when it comes to sales volume.

Furthermore, in an age where many restaurant companies would be happy to have flat same-store sales, Crumbs' same-store sales have jumped about 15% for each of the past few years, Bauer says. And the company gets about a $19 check average, as visitors tend to buy batches of its cupcakes, which come in more than 75 varieties and whose prices range from about $2.50 to $4.50 each, depending on size and toppings.

"We still seem to be in the growth stage of the cupcake trend, and nobody has taken a dominant position in this arena," says Darren Tristano, executive vice president at Chicago-based food and beverage consultant Technomic. "Three years from now, cupcakes may not be the top of the trend list, but that's where a good unit economics will put them in position for years to come."
Baking a Good Business Plan

In terms of quality, Crumbs appears to match up well against its independent competitors. Crumbs' original location in New York City's Upper West side gets about three-and-a-half stars, on average, in its 184 reviews on user-review site Yelp, while Magnolia's Greenwich Village shop, which opened in 1996, averages about three stars from its more than 1,200 reviewers. Across the country, Sprinkles' Beverly Hills shop gets about three-and-a-half stars, the same rating Yelpers give the Crumbs store two blocks away.

Sponsored Links

Bauer, who says the company is eyeing markets such as San Francisco, Boston and Atlanta for expansion, acknowledges the risks of rapid growth, but he says Crumbs will be different from Krispy Kreme or Pinkberry. First, Crumbs will continue to offer its cupcakes only at its stores and for delivery via its website. It won't engage in the broader distribution strategy that Krispy Kreme attempted, which cannibalized its store sales.

And unlike Pinkberry's frozen yogurt, he notes, cupcakes appeal to customers year-round and in cold-weather climates. In addition, he says, variety is another advantage Crumbs has over Pinkberry's essentially single-product approach because his chain also sells larger cakes, danishes, scones and beverages.

As for Magnolia -- which has four locations in New York, one in Los Angeles and an outpost at the Bloomingdale's in Dubai -- or Sprinkles -- which has 10 U.S. stores and is preparing to jump into another dozen U.S. markets, plus London, Paris and Tokyo -- Bauer says the more, the merrier.

"Eight years ago, cupcakes weren't even a category," Bauer says. "There are a lot of great bakers, but it takes more than a good recipe. You have to run a business."